The Effect of Seniority and Security Covenants on Bond Price Reactions to Credit News

Résumé du livre

This paper examines the daily abnormal returns of corporate bonds with different priorities following Moody's announcements. We show that bond returns react significantly positive (negative) following upgrade (downgrade) Watchlist events but not necessarily following rating change events. Because Watchlist news precede rating changes, this suggests that the Watchlist contains less contaminated information, leading to the stronger short-run price effects. Additionally, we find that subordinated bond prices react more than secured bonds to Watchlist news. However, this finding does not hold when we compare investment and non-investment grade bonds. Cross-sectional regression results confirm this after controlling for issue- and issuer-specific characteristics. The results imply that restrictive bond covenants affect corporate bond risk premia associated with unexpected credit news, which we provide a theoretical explanation.